Gilt-edged dollar fears

Gilt-edged dollar fears

John Maynard Keynes is back, and so is his “barbarous relic".

Ten days before Diwali, gold prices in India skyrocketed 7.78% from what they were in early August. The Rs15,822 price tag for 10g is sure to dampen jewellery sales, but it also points to remarkable global trends in currency.

Through the centuries, gold has been the ultimate store of value. This was the “relic" whose inflexible use Keynes blamed for worsening the Great Depression. But no matter how maligned, gold will be the asset investors turn to when others—including fiat currencies—are in doubt. That’s what seems to be happening now: Global spot prices are up 3.4% from a week ago.

And it’s not just gold: The rupee has been at a year-long high against the dollar this week. Other currencies have also rallied when pitted against the dollar. When Lehman collapsed last September, the immediate “safe haven" was US treasurys; hence, the dollar rose. That panic is no more.

Commentators have been screaming about the end of the dollar’s status as reserve currency ever since Chinese central bank governor Zhou Xiaochuan suggested it in March. Much of this is couched in the hyperbole of China’s rise, but the last few weeks have borne out some of these concerns.

First, China is no longer the only one voicing concerns. World Bank president Robert Zoellick said last week that the dollar’s reserve currency shouldn’t be taken for granted. The Independent reported this week that oil producing nations are in talks to replace the dollar as the currency to settle trades (though the countries in question have denied this). It’s worth remembering that when the dollar depreciated in the aftermath of the Bretton Woods’ collapse in 1971, oil producing nations were worried enough about the dollar value of their commodity to trigger an oil shock.

Second, instead of being used as a safe asset, the dollar is now popular for carry trade—traders borrow dollars and then invest in other high-yielding currencies. Little surprise, given that the US Federal Reserve’s continued accommodation, along with a rising budget deficit that the Fed is monetizing, is keeping interest rates low.

Both these ideas—monetary and fiscal stimulus—go back to Keynes. Ironically, their unsustainable use is now bringing investors back to the same gold he hated so much.

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